A tax professional often learns when providing tax preparation or tax planning services to a business owner that the owner has misclassified employees as independent contractors. Workers classified as employees receive a Form W-2, Wage and Tax Statement, whereas workers classified as independent contractors receive Form 1099-MISC, Miscellaneous Income. Employers generally prefer to classify a worker as an independent contractor to avoid paying employment taxes (FICA and Medicare) and employee benefits, and to avoid complying with a myriad of employer rules including the recently enacted Patient Protection and Affordable Health Care Act (Obama Care).
The IRS and the U.S. Department of Labor (DOL) have audit programs to identify employers who may be misclassifying workers. The determination between employee and independent contractor is based on whether the employer has the right to control the worker. If the worker is controlled, the worker is an employee. If not controlled, the worker is an independent contractor. While this sounds like an easy determination, in practice it is complex and often subjective. IRS Revenue Ruling 87-41 lists 20 factors that the IRS will consider when making its determination as to whether a worker is an employee under the common law rules.
When discussing the situation with the business owner, the tax professional learns that the business owner is relying upon beliefs that give him a false sense of security that could result in costly consequences to the employer. What are those false senses of security?
- The employer argues that the worker signed an agreement whereby he states that he is an independent contractor. IRS auditors look through the contract and make their determination looking at the evidence as to who has control. The IRS will normally only consider the contract if its analysis of the other factors is not determinative.
- “My competition is classifying its workers as independent contractors and therefore I am correct in doing so.” Before depending upon what others are doing, research as to industry practices needs to be done and documented evidence needs to be obtained to substantiate the independent contractor status.
- The employer argues that the worker has been hired and is under probation until a final hiring decision can be made. The problem with this approach is that the worker performs the exact same job duties and receives both a Form 1099 during the trial period and then receives a Form W-2 when the probationary period lapsed.
- The employer argues that the workers were part-time, seasonal or temporary and thus would not be considered employees. The IRS and DOL will compare the duties and responsibilities of these employees against those of the full time or permanent employees and if the work is found to be similar, it will find that these workers are employees.
- The employer requires that the worker form a corporation since Form 1099s are not required to be sent to corporations. While this approach may fall under the IRS radar screen, the employer could face very significant penalties, including the evasion of taxes.
- The worker works at home and the employer therefore theorizes that the worker is an independent contractor. The IRS realizes that many employers allow employees to work at home, and when the worker’s duties are controlled by the employer, the IRS will find that the worker is an employee.
While the IRS and DOL have historically assessed taxes and penalties for misclassifying workers as independent contractors, the penalties will now increase as a result of the Patient Protection and Affordable Health Care Act (Obama Care).
Note: Because the classification of a worker is dependent upon the 20 common law criteria, each business’s tax situation may be different. Accordingly, if you want to learn more about the proper classification of your workers, we invite you to call 610-594-2601 today to make an appointment at our Exton PA CPA office to discuss your situation.
You can also schedule a consultation at Click Here. To learn more about various tax and business services, visit Tax Preparation Services and Small Business Accounting Services
Copyright © 2014 Keystone Financial Solutions, P.C. All rights reserved. BE SURE TO READ THE DISCLAIMER PAGE: Content in this blog is for educational purposes only and should not be considered as the rendering of tax, legal or investment advice. The publisher of this blog makes no representations as to the accuracy or completeness of any information herein, will not be liable for any errors or omissions, and shall not assume liability for any losses, injuries, or damages from the display or use of this information.